Investors rallied around China in excitement when it announced in October that Covid restriction would finally be coming to an end, but its reopening has left many underwhelmed.
The MSCI China index is down 11.7% this year despite optimistic forecasts, yet Dale Nicholls, manager of the Fidelity China Special Situations trust, said investors should not think that China’s reopening is over.
“It was slightly disappointing but not surprising,” he said. “This recovery was always going to be bumpy. It's definitely not going to be a straight line, but I think the underlying fundamentals are there and clearly consumption is going to be the main driver of recovery.”
Total return of MSCI China in 2023
Source: FE Analytics
China’s reopening did not result in the boom of consumer spending that markets had anticipated and it will take time for this rebound to fully materialise, according to Nicholls.
Consumers will begin to spend their lockdown savings slowly rather than in the burst markets had expected, meaning the recovery is still in its early stages.
“Expectations were too high about the pace of recovery, but there’s a lot of room for consumption to grow,” Nicholls explained. “People will get out travelling more, so the outlook for recovery is good.
“It's going to be much better than we see in most parts of the world. In terms of that trajectory of recovery, China stacks up pretty well.”
Indeed, the World Bank forecast earlier this year that GDP in China would grow 4.3%, while the global average would trail behind at 1.7%.
Consumer spending will play a pivotal role in China’s recovery, but Chris Metcalfe, chief investment officer at IBOSS, said the rebound will play out differently from the west.
“The effect of the draconian approach on Chinese people is a world away from our experience of lockdown,” he said. “For us, it was generally inconvenient, but it was way worse for China.
“People in China have been traumatised and it will take a lot more to change that mindset. As soon as we could go out and spend we were off, but it's been different for China.”
It will take longer for Chinese consumers to become confident in spending again, meaning those lockdown savings will be released back into the economy slowly.
If anything, Metcalfe said this more gradual growth gives him more conviction in China now the excitable hype has left the market.
“It's been a slow burn, but unless you’re investing on a quarterly basis, that doesn't really matter,” he said. “They will get there, so I’d say I'm more bullish on the China situation now having had the muted response to the reopening than I was before.”
Nicholls increased his allocation to consumer companies by between 5 to 10 percentage points this year in his Fidelity China Special Situations trust to benefit from increased spending.
Performance of trust vs sector and benchmark since manager start
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Source: FE Analytics
This brings consumer discretionary exposure in the portfolio up to 38.4%, which is 9.5 percentage points higher than the MSCI China average.
“They’re very domestically focused,” Nicholls said. “I do have some companies that actually have interesting global stories in terms of rollout, but they're not very common.
“There's real value emerging there. You do get these swings over time, but I think generally they're good businesses that are going to benefit from recovery. From a risk/reward perspective, that's been a big area of focus.”
This was confirmed by Sandy Pei, deputy manager of the Federated Hermes Asia ex-Japan Equity fund, who said China has strong domestic demand that consumer companies could benefit from.
“If you look at how China has grown over time, it has become a big consumer market,” she said. “It produces locally and sources locally, so it’s very efficient. The Chinese consumer was growing and led to that golden age.”
These consumer companies could have strong tailwinds from China’s reopening, but they’re still trading at discounts, which created a good entry point for Nicholls.
He said: “A lot of these stocks are approaching single digit multiples again for pretty strong growth stories. Most of them are reducing their loss-making businesses too, so that alone can drive earnings growth.
“Coming out of Covid, you're definitely going to see earnings growth and economic growth that outpaces the world, so now is a time to be positive.”